Federal Reserve Act

An Act to provide for the establishment of Federal reserve banks, to furnish an elastic currency, to afford means of rediscounting commercial paper, to establish a more effective supervision of banking in the United States, and for other purposes

The Act

The Federal Reserve Act created a system of private and public entities; there were to be at least eight, and no more than 12, private regional Federal Reserve banks. Twelve were established, and each had various branches, a board of directors, and district boundaries. The Federal Reserve Board, consisting of seven members, was created as the governing body of the Fed. Each member is appointed by the President of the United States and confirmed by the U.S. Senate. In 1935, the Board was renamed and restructured. Also created as part of the Federal Reserve System was a 12-member Federal Advisory Committee and a single new United States currency, the Federal Reserve Note. The Federal Reserve act did create a national currency, but more importantly, the act was to create a monetary system that could respond effectively to the different stresses in the banking system and create a stable financial system. Along with the goal of creating a national monetary system and financial stability, the Federal Reserve Act also provided many other functions and financial services for the economy such as a check clearing and collection for all members of the Federal Reserve.

With the passing of the Federal Reserve Act, Congress required that all nationally chartered banks become members of the Federal Reserve System. These banks were required to purchase specified non-transferable stock in their regional Federal Reserve banks, and to set aside a stipulated amount of non-interest bearing reserves with their respective reserve banks. Since 1980, all depository institutions have been required to set aside reserves with the Federal Reserve. Such institutions are entitled to certain Federal Reserve services. State chartered banks were given the option of becoming members of the Federal Reserve System and in the case of the exercise of such option were to be subject to supervision, in part, by the Federal Reserve System. Member banks became entitled to have access to discounted loans at the discount window in their respective reserve banks, to a 6% annual dividend in their Federal Reserve stock, and to other services.

Background

Central banking has made various institutional appearances throughout the history of the United States. These institutions started with the First and Second banks of the United States, which were championed in large part by Alexander Hamilton.

The First Bank of United States

The American financial system was deeply fragmented after the American Revolutionary War. The government was burdened with large wartime debts, and the new republic needed a strong financial institution to give the country a resilient financial footing. Alexander Hamilton and Thomas Jefferson had opposing views regarding whether or not the US could benefit from a European-style national financial institution. Hamilton was in favor of building a strong centralized political and economic institution to solve the country’s financial problem. He argued that a central bank could bring order to the US monetary system, manage the government’s revenues and payments, and provide credit to both the public and private sectors. On the other hand, Jefferson was deeply suspicious of a central bank because, he argued, it would undermine democracy. Jefferson and Southern members of congress also believed that a strong central financial institution would serve commercial interests of the north at the expense of Southern-based agriculture interests whose credit was provided by local banks during the post-revolutionary war era. The First Bank of the United States was established in 1791 chartered for a period of twenty years. The US government was the largest shareholder of the bank. Despite its shareholder status, the government was not permitted to participate in management of the bank. The bank accepted deposits, issued bank notes, and provided short-term loans to the government. It also functioned as a clearinghouse for government debt. The bank could also regulate state-charted banks to prevent overproduction of banknotes. The bank was very successful in financing the government and stimulating the economy. In spite of its successes, hostility against the bank did not fade. Jeffersonians questioned the bank’s constitutionality. In 1811, the first bank of the United States failed to be renewed by one vote in both the House and the Senate.[2][3]

The Second Bank of the United States

After the War of 1812, economic instability necessitated the creation of a second national bank. Due to expanding money supply and lack of supervision, individual bank activity sparked high inflation. In 1816, a second national bank was created with a charter of twenty years. Three years later, during the panic of 1819 the second bank of the United States was blamed for overextending credit in a land boom, and would tighten up credit policies following the panic (Wiletnz, 2008[citation needed]).

The Second bank was unpopular among the western and southern state-chartered banks, and constitutionality of a national bank was questioned. President Jackson would come into office, and wished to end the current central bank during his presidency. Under the premise that the bank favored a small economic and political elite at the expense of the public majority, the Second Bank became private after its charter expired in 1836, and would undergo liquidation in 1841.

For nearly eighty years, the U.S. was without a central bank after the charter for the Second Bank of the United States was allowed to expire. After various financial panics, particularly a severe one in 1907, some Americans became persuaded that the country needed some sort of banking and currency reform that would,[citation needed] when threatened by financial panics, provide a ready reserve of liquid assets, and furthermore allow for currency and credit to expand and contract seasonally within the U.S. economy.

Some of this was chronicled in the reports of the National Monetary Commission (1909–1912), which was created by the Aldrich–Vreeland Act in 1908. Included in a report of the Commission, submitted to Congress on January 9, 1912, were recommendations and draft legislation with 59 sections, for proposed changes in U.S. banking and currency laws.[4] The proposed legislation was known as the Aldrich Plan, named after the chairman of the Commission, Republican Senator Nelson W. Aldrich of Rhode Island.

The Plan called for the establishment of a National Reserve Association with 15 regional district branches and 46 geographically dispersed directors primarily from the banking profession. The Reserve Association would make emergency loans to member banks, print money, and act as the fiscal agent for the U.S. government. State and nationally chartered banks would have the option of subscribing to specified stock in their local association branch.[4] It is generally believed that the outline of the Plan had been formulated in a secret meeting on Jekyll Island in November 1910, which Aldrich and other well connected financiers attended.[5]

Since the Aldrich Plan gave too little power to the government, there was strong opposition to it from rural and western states because of fears that it would become a tool of bankers, specifically the Money Trust of NYC.[6] Indeed, from May 1912 through January 1913 the Pujo Committee, a subcommittee of the House Committee on Banking and Currency, held investigative hearings on the alleged Money Trust and its interlocking directorates. These hearings were chaired by Rep. Arsene Pujo, a Democratic representative from Louisiana.[7]

In the election of 1912, the Democratic Party won control of the White House and both chambers of Congress. The party's platform stated strong opposition to the Aldrich Plan. The platform also called for a systematic revision of banking laws in ways that would provide relief from financial panics, unemployment and business depression, and would protect the public from the "domination by what is known as the Money Trust." The final plan, however, was quite similar to the Aldrich Plan, with a few revisions. Sen. Carter Glass made these revisions, although the main premise of the Aldrich Plan was in there.[8] Changes in the Banking and Currency System of the United States]. House Report No. 69, 63d Congress to accompany H.R. 7837, submitted to the full House by Carter Glass, from the House Committee on Banking and Currency, September 9, 1913. A discussion of the deficiencies of the then current banking system as well as those in the Aldrich Plan and quotations from the 1912 Democratic platform are laid out in this report, pages 3–11.[9]

Legislative history of the Act

The Federal Reserve Act was a part of the banking and currency reform plan advocated by President Wilson in 1912. The chairmen of the House and Senate Banking and Currency committees sponsored this legislation; representative Carter Glass, a Democrat of Virginia and Senator Robert Latham Owen, a Democrat of Oklahoma. According to the House committee report accompanying the Currency bill (H.R. 7837) or the Glass-Owen bill, as it was often called during the time.

Attempts to reform currency and banking had been made in the United States prior H.R. 7837. The major first form of this type of legislation came through with the First Bank of the United States in 1791. Championed by Alexander Hamilton, this established a central bank that included in a three-part expansion of federal fiscal and monetary power (including federal mint and excise taxes). Attempts were made to extend this bank’s charter, but they would fail before the charters expiration in 1811, which would lead to the creation of the Second Bank of the United States. In 1816 the U.S. Congress chartered this Second bank for a twenty-year period to create irredeemable currency with which to pay for the costs of the War of 1812. The creation of congressionally authorized irredeemable currency by the Second Bank of the United States amounted to taxation by inflation. Congress did not want state-chartered banks as competition in the inflation of currency. The charter for the Second Bank would expire in 1836, leaving the U.S. without a central bank for nearly eighty years. The last major form of legislation preceding the Federal Reserve Act came in 1908 with the Aldrich-Vreeland Act, which was the initial response the Financial Panic of 1907, and established the National Monetary Commission, which recommended the Federal Reserve act of 1913.

According to the House committee report accompanying the Currency bill (H.R. 7837) or the Glass-Owen bill, the legislation was drafted from ideas taken from various proposals, including the Aldrich bill. However, unlike the Aldrich plan, which gave controlling interest to private bankers with only a small public presence, the new plan gave an important role to a public entity, the Federal Reserve Board, while establishing a substantial measure of autonomy for the (regional) Reserve Banks which, at that time, were allowed to set their own discount rates. Also, instead of the proposed currency being an obligation of the private banks, the new Federal Reserve note was to be an obligation of the U.S. Treasury. In addition, unlike the Aldrich plan, membership by nationally chartered banks was mandatory, not optional. The changes were significant enough that the earlier opposition to the proposed reserve system from Progressive Democrats was largely appeased; instead, opposition to the bill came largely from the more business-friendly Republicans instead of from the Democrats.[citation needed]

After months of hearings, debates, votes and amendments, the proposed legislation, with 30 sections, was enacted as the Federal Reserve Act.

Subsequent amendments

The Federal Reserve act has undergone many amendments after its implementation. Early, bureaucratic amendments were made to account for states like Hawaii and Alaska’s admission to the union; such as district restructuring and jurisdiction specifications.[10]

Charter extension

The Federal Reserve Act was originally granted a twenty-year charter, to be renewed in 1933. This clause was amended on February 25, 1927: "To have succession after the approval of this Act until dissolved by Act of Congress or until forfeiture of franchise for violation of law." 12 U.S.C. ch. 3. As amended by act of Feb. 25, 1927 (44 Stat. 1234). The success of this amendment is notable, as in 1933, the US was in the throes of the Great Depression and public sentiment with regards to the Federal Reserve System and the banking community in general had significantly deteriorated. Given the political climate, including of Franklin D. Roosevelt’s administration and New Deal legislation, it was uncertain whether the Federal Reserve System would survive.

The Federal Open Market Committee

In 1933, by way of the Banking Act of 1933, the Federal Reserve Act was amended to create the Federal Open Market Committee (FOMC), which consists of the seven members of the Board of Governors of the Federal Reserve System and five representatives from the Federal Reserve Banks. The FOMC is required to meet at least four times a year (in practice, the FOMC usually meets eight times) and has the power to direct all open-market operations of the Federal Reserve banks.

12 USC § 225a

On November 16, 1977, the Federal Reserve Act was amended to require the Board and the FOMC "to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates." This same amendment stated that the member governor proposed by the President to be Chairman would have a four-year term as Chairman and would be subject to confirmation by the Senate (member governors per se each have 14 year terms, with a specific term ending every two years). The Chairman was also required to appear before Congress at semi-annual hearings to report on the conduct of monetary policy, on economic development, and on the prospects for the future. The Federal Reserve Act has been amended by some 200 subsequent laws of Congress. It continues to be one of the principal banking laws of the United States.

Implications and impacts of the Federal Reserve Act

The passing of the Federal Reserve act of 1913 carried implications both domestically and internationally for the United States economic system.[11] The absence of a central banking structure in the U.S. previous to this act left a financial essence that was characterized by immobile reserves and inelastic currency (Johnson, 14). Creating the Federal Reserve gave the federal government control to regulate inflation, even though the government control over such powers would eventually lead to decisions that were politically popular and economically devastating. Some of the most prominent implications include the internationalization of the U.S. Dollar as a global currency, the impact from the perception of the Central Bank structure as a public good by creating a system of financial stability (Parthemos 19-28), and the Impact of the Federal Reserve in response to economic panics.[12] The Federal Reserve Act also permitted national banks to make mortgage loans for farm land, which had not been permitted previously.[13]

Criticisms of the Act

Throughout the history of the United States, there has been an enduring economic and political debate regarding the costs and benefits of central banking. Since the inception of a central bank in the United States, there were multiple opposing views to this type of economic system. Opposition was based on protectionist sentiment; a central bank would serve a handful of financiers at the expense of small producers, businesses, farmers and consumers, and could destabilize the economy through speculation and inflation. This created even further controversy over who would select the decision-makers in charge of the Federal Reserve. Proponents argued that a strong banking system could provide enough credit for a growing economy and avoid economic depressions. Other critical views included the belief that the bill gave too much power to the federal government after the senate revised the bill to create 12 board members who were each appointed by the president.

Preceding the creation of the Federal Reserve, no U.S. central banking systems lasted for more than 25 years. Some of the questions raised include: whether Congress has the Constitutional power to delegate its power to coin money or issue paper money, whether the structure of the federal reserve is transparent enough, whether the Federal Reserve is a public Cartel of private banks (also called a banking cartel) established to protect powerful financial interests, fears of inflation, high government deficits, and whether the Federal Reserve's actions increased the severity of the Great Depression in the 1930s. However, the debate over the right to coin money was minimal due to the fact the US government had already done this in the past. [14] (and/or the severity or frequency of other boom-bust economic cycles, such as the late 2000s recession).[15][16]

References

↑ 4.04.1Report of the National Monetary Commission. January 9, 1912, letter from the Secretary of the Commission and a draft bill to incorporate the National Reserve Association of the United States, and for other purposes. Sen. Doc. No. 243. 62d Congress. U.S. Government Printing Office. 1912.

↑Wicker, Elmus (2005). "The Great Debate on Banking Reform: Nelson Aldrich and the Origins of the Fed". Ohio University Press. See also book review.External link in |publisher= (help)<templatestyles src="Module:Citation/CS1/styles.css"></templatestyles>

↑Money Trust Investigation - Investigations of Financial and Monetary Conditions in the United States under House Resolutions Nos. 429 and 504 before a subcommittee of the House Committee on Banking and Currency. 27 Parts. U.S. Government Printing Office. 1913.